Matt Taibbi Falls For A Naked Short Selling Hoax Video

Matt Taibbi’s journey down the rabbit hole of naked short selling
is getting weirder and weirder.

Today
he posted a video allegedly showing a “day trader” shorting
tens of billions of shares of a stock with a float of only 5.5
billion shares. The trader allegedly executes his trades through
the clearinghouse Penson.

"If you don’t need to actually find the stock before you sell it,
there’s no real brake on speculative naked short-selling," Taibbi
writes. "If a clearing firm will give you a locate no matter how
big your request is, there is no real barrier out there to stop
this kind of activity."

There are plenty of things wrong with this video, and with the
conclusion Taibbi draws. Clearing firms will not execute orders
without regard to the size of the order, there are real brakes on
speculative naked short selling, and real barriers exist to stop
"this kind of activity."

Too Speedy. The first thing that rings false the
speed with which the trade is executed. The trader apparently
manages to short billions of shares in mere seconds. Penson may
be a popular and efficient clearinghouse but there is no way they
are that fast. There's just no way to have instant execution of a
trade of this size.

“It takes minutes to a half-hour for a request to come back from
Penson,” a trader who clears through the firm tells us.

Too Big Of A Trade. You cannot sell tens
of billions shares without someone wanting and able to buy those
billions of shares. This trade involves placing a sell order for
more than the total volume of all US equity markets combined for
any single trading day.

Too Much Leverage. More importantly,
almost no trader using Penson as his clearing house would have
the buying power to put in an order this large. This should sale
would require billions of dollars of buying power. The buying
power of any trader is a multiple of the money deposited with
Penson. That is, it is determined by the maximum margin account
available to the trader.

For ordinary, retail traders—the kind of people likely to be
called “day trader”—the maximum intra-day leverage is 4 to 1.
This is set by FINRA regulation. In order to short tens of
billions of shares on any stock worth more than $1, the trader
would have to have billions in his brokerage account.

Small hedge funds often use a more sophisticated kind of margin
account that allows for more leverage. It's calculated by the
clearing firm exclusively for each of their clients who get it
based on their style of trading and track record. A risk averse
day-trading hedge fund could get leverage as high as 7 to 1
intraday. These typically require a minimum of at least $1
million in the account with the clearinghouse.

Any trader with the billions of dollars necessary to get
execution on the trade Taibbi describes would be unlikely to be
clearing through Penson. He would be trading through Goldman
Sachs or JP Morgan.

It’s too risky. There is a good reason for
Penson and other clearing houses to limit leverage in this way,
even beyond the regulations. They face counter-party risk
when allowing traders to short stocks. If the stock increases in
value and the trader cannot pay for the stocks he is short, the
clearinghouse will have an obligation to make good with the
Depository Trust Company.

This trade would be a disaster. If tens of
billions of shares of a stock were sold like this, it would make
headlines and single handedly wipe out the stock. Likewise, when
the trader bought up the shares to close the trade and deliver
the shares to the buyers, he’d face a self-imposed massive short
squeeze. Buying shares pushes the price up. He'd get
crushed.

Taibbi is reading too much into the video.
Although Taibbi concludes his description of the video by writing
“The trade goes through,” this isn’t what happens. This
screen shot is nothing more than the purported “ok” from some
trading system that an attempt is made to locate shares.
The quantity is requested and there is no indication that the
entire amount was approved.

Many trading systems will accept any amount for the request but
only return the approval for the quantity that the firm was
actually able to locate. There is no evidence that this trading
screen is somehow linked in real time to Penson. Had this order
actually been attempted to be entered into the Penson system,
multiple risk checks and parameters would rejected the order.

In short, there’s just no way the trade represented in this video
is real. It certainly doesn’t reflect the reality of short
selling.